I thought this was an interesting article about Search Engine Arbitrage, which defines its meaning well; the original article can be found by following the link at the end of this article.

Search Engine Arbitrage is defined as buying ads from a search engine and then selling ads at a higher price. For example the arbitrager buys the term “rare dirty coin” at Google and pays $0.05 for the ad because no one else is advertising on that term. Once the user clicks on the arbitrager’s ad he is taken to a page about “gold coins”. Let’s say the term “gold coins” makes $0.70 per click. The Arbitrager would need to convert 1 in 13 people to make a profit or 1 in 14 people to break even. We can think about Arbitrage as a keyword funnel, collect a lot of small terms and lead them into a big term. I think search engine arbitrage is another brilliant way of Mining the Longtail. There are drawbacks to arbitrage though, the market can only support so many of them. Geosign just announced they raised $160 Million from American Capital. With big announcements like this there is a lot of attention being focused on the keyword arbitrage market.

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Let’s say there are 50 companies engage in large scale keyword arbitrage right now, they all make a return on their investment of 400%. If the market had 2,000 arbitrage companies I know the return would be much lower for all. I see algorithms getting smarter and machine evaluation processes getting faster, in short, to survive long term companies will need to have smarter machines then the next guy. The beauty of the longtail is that it can support a lot of companies. So it may take 30,000 arbitragers to drive average profit to 5%. The Fat Front of the Longtail will be eaten up very quickly and arbitrages that try to survive there will die, only 10 companies can show up for a term. So if 30 companies rule this industry we can see that there will be a collapse at some point and rest of the companies will fold or be bought out. However, reselling a poorly preforming arbitrage company will be harder then selling sand to an Egyptian.

Frank Schilling has a good perspective on how search engine arbitrage compares to domain arbitrage. He point out that only one company controls a domain, meanwhile anyone can bid on a search engine term. Traffic on a domain will never go away and a competitor will never drive costs up for owning the domain. For the king of domains it is easy, he can focus on domains and weather the arbitrage storm. Even if he enters the arbitrage business he has a safety net of 300,000+ generic domains with tons of type-in traffic. In Franks own words, “Homer Simpson himself could not kill Name Administration“.

My take on all this is that search engine arbitrage is here to stay but the margins will get thinner in the future. We can expect the leaders of today’s pure arbitrage business to get tossed out. Historically, the first to market in a highly competitive environment will lose their lunches to the next smartest company. Mosaic and Netscape are prime examples but I am sure there are more. Margins will compress rather quickly and the smart guys will be left. For the companies that want a re-do, they will need to have a back up plan. Marchex is a good example of a company with backup plan. They have a huge domain portfolio that has natural traffic.

There is a clear evolution for domain owners to play in this space: (Domainer > Registrar > Media Company) Once a domainer has hit the Media Company phase they can start playing in arbitrage. There are more direct routes to becoming an arbitrage company, start as an SEM company. But SEM companies are more pure play and don’t have backup plans, so I predict will be the ones that get squeezed out as margins compress.